Drivers, Don't Panic

By

Cheryl Strauss Einhorn

Updated March 26, 2001 12:01 a.m. ET

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A counter-seasonal peak. That's what we may be seeing in the gasoline market now. For although crude oil prices slid to a 2 1/2-month low last week -- as fears about the economy overrode the impact of OPEC's announcement that it was shaving production by another million barrels-gas prices soared. They're trading near their highest levels in a decade, at more than 90 cents per gallon, amid the lowest inventories in nearly seven years.

Key Commodities Index

CRB Group Indexes

3/23

3/16

Yr. Ago

CRB Futures

214.47

215.11

212.74

Industrials

179.16

183.03

202.91

Grain/Oils

158.72

161.33

173.88

Livestock

263.28

265.64

256.21

Energy

248.91

242.51

246.71

Precious Metals

250.08

250.33

256.59

Barron's ~ Bridge Telerate

Sell. The market is about to weaken. Not only should stocks rise, but falling oil prices will cut the gas rally short, because 87% of spot gas prices are a function of crude prices. "I think gas prices will be 70 cents per gallon by August," predicts Andrew Fairbanks, Merrill Lynch's senior refining analyst.

"We could see a counter-seasonal peak," agrees Fred Leuffer at Bear Stearns.

That's good news for consumers, who may pay a nickel less at the pump in coming months, or about $1.40 per gallon on average across the United States. However, it's bad news for shares of high-flying gas refiners. Companies like
Valero Energy
,
Ultramar Diamond Shamrock
and
Sunoco
have not only seen their stocks rise-they're up 13%, 45.2% and 9.7%, respectively, in the past year's difficult stock market.They've also recently been enjoying their highest margins in 10 years lately.

Now, however, Fairbanks figures that as gas prices decline, gross refining margins may be cut in half; he expects them to shrink from $7 per barrel to $3-$4. Leuffer says that as a result, he sees a 15% downside risk in refining shares, adding: "As the year progresses, these companies will see more difficult comparisons."

After experiencing such heady times, as gas prices falter, refiners may also suffer from added cost pressures from rising prices for ingredients like oxygenates. These are used to make the cleaner, reformulated fuel (RFG) that is needed in many big urban centers during the summer driving season. And oxygenates are made from natural gas, which has also become very expensive lately amid low inventories.

In fact, as prices of natural gas soared to $10 per million British thermal units this winter, refiners like Valero, that make reformulated gasoline oxygenates for its own and customer use, shuttered capacity. The company closed down 80,000 barrels per day of its production between December and January, equivalent to one-third of the total oxygenate market.

Now "we're behind on our production," says Mary Rose Brown, a vice president at Valero. "For a while, we weren't selling anything into the market at all."

Inventory statistics show the picture: The Department of Energy's most recent data, dating back to February, show that while stocks of reformulated gasoline stood at 10.3 million barrels last year, this year there are only 7.9 million stored away. As a result, prices of reformulated gasoline command a 24-cent premium over conventional gas prices.

But that's not the only reason gas prices are in trouble. Leuffer at Bear Stearns notes that since gas-refinery margins have been so good, refiners waited until the last minute to take their seasonal downtime to clean their facilities between the winter heating season and summer gas season. Thus, current shutdowns have been much higher than normal, meaning less gas is being produced.

Refiners are running at about 89% of capacity now, versus a more normal 93% -or better-for this time of year. About 450,000 barrels per day, or about 3% of capacity, should be back on the market "within the next week," predicts Leuffer. "On the margin, that is significant."

Thus, supplies should rise. Yet "demand is not doing anything," he says, predicting no growth in gas demand this year. With softening economic activity and the current high pump prices, usage may wane. Also, even after transportation costs, the high gas prices have made it attractive-and profitable-for foreigners to sell their gas here. Imports from Europe are up and "should remain high," Leuffer says. Result: "There will be a pullback in gas prices."

"An imminent recovery does not appear to be in the cards," says Bill O'Neill, Merrill Lynch's managing director of commodity research. "It seems likely that it will be the fourth quarter at the earliest before the global economic scenario would dictate a significant upturn in commodity demand." Even more bearish, he adds, "it would be unreasonable to extend that time-frame into the first quarter of next year."

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